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Employee Life Insurance May Hold the “Key”

| April 13, 2018
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If your key employee significantly contributes to the success of your business, have you considered how losing such an employee could impact your operations? Key employee life insurance can help protect your business from the financial consequences of a key employee’s death. During the key person’s tenure with the company, life insurance may strengthen the credit of the business, as well as provide needed cash for emergencies. In addition, when the key employee dies, key employee life insurance may reinforce the capital structure of the business, maintain lines of credit, and pay for training costs of a replacement. 

Consider the variables by looking at a hypothetical case: Alfred, a talented chemical engineer, works at XYZ Plastics, Inc., a plastics fabrication company. In his seven years with the company, Alfred has developed several important compounds, in addition to an innovative new process for manufacturing automobile engine blocks. Because he has been so instrumental to XYZ Plastics, and his work has propelled the company to the forefront of its industry, Alfred is considered one of the company’s key employees. 

XYZ Plastics’ owners realize the importance of Alfred to the success of the company and have purchased a key employee life insurance policy. This type of policy could be of great benefit in the event of the loss of such a valuable employee. 

How Does the Employer Benefit?

A company like XYZ Plastics may benefit from life insurance held by the company on key employees in the following ways: 

  • Proceeds from the policy can provide XYZ Plastics with funds to compensate for the loss that could result in the event of a key employee’s death. The company could then use the money to recruit a new employee with credentials and capabilities similar to those of Alfred, train the new employee, promote additional sales, or provide for improvements that would eventually compensate for the loss sustained following the death of such a valuable employee. 
  • Permanent life insurance on a key employee could provide XYZ Plastics with an accumulation of funds to be used in emergencies. Payment of the annual premiums provides an orderly accumulation of funds with an increasing cash surrender value. Ordinarily, the policy has a guaranteed cash value, as the cash surrender value can be determined for any period of time. Guarantees are based on the claims-paying ability of the issuing company. 
  • By maintaining key employee insurance, XYZ Plastics may strengthen its credit. The insurance may be used as supporting collateral for loans and may be considered evidence that the company will continue to meet its debt obligations in the event of the key insured employee's death. 

How Does the Key Employee Benefit?

While life insurance on a key employee can help protect XYZ Plastics against the premature death of Alfred, there is no guarantee that such a key employee will remain with the company until retirement or death. Therefore, establishing a deferred compensation plan for that employee may provide an incentive for the desired employee to stay with the company. 

Under this plan, XYZ Plastics would enter into a contract with Alfred to pay certain benefits upon his retirement. XYZ Plastics may also require Alfred to promise not to compete (a noncompete agreement) with the company after his retirement. The contract is a separate plan and is not tied directly to the insurance policy. However, life insurance can be an advantageous way to fund the deferred compensation plan. 

A combination key employee deferred compensation plan may be adopted and funded with a single life insurance policy. That policy would provide indemnity to XYZ Plastics in the event of Alfred’s death and would also serve as a source of retirement income for Alfred upon his retirement. XYZ Plastics would take out a life insurance policy on Alfred; he would not be a party to this insurance contract. Then, at the same time, XYZ Plastics and Alfred would both enter into the deferred compensation plan. 

Therefore, XYZ Plastics would have indemnity protection until Alfred’s retirement date. Upon that date, the company can surrender the policy and use the proceeds to make the deferred compensation payments. This type of key employee insurance plan does not have to cover any specific number or class of employees. It may be particularly appropriate for companies that do not wish to establish qualified deferred compensation plans. 

If you have employees who are vital to the successful operation of your company, you may want to consider taking the steps that XYZ Plastics took in the example and purchase life insurance as protection and incentive for your key employees.

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